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New research shows that Minnesota’s state government increased smoking by taxing e-cigarettes

Last Friday I illustrated a couple of concepts from Econ 101. ‘Complementary goods’ are those like bread and butter, which are consumed together. As the price of one rises, demand for both goods will fall. ‘Substitute goods’ are those like butter and margarine, they are consumed instead of each other. As the price of one rises, demand for the other will rise.

Substitute goods – Cigarettes and e-cigarettes

Minnesota’s policymakers have given us another example of ‘substitute goods’. E-cigarettes are a substitute good for cigarettes. Many people who would smoke cigarettes use e-cigarettes instead. Many people who want to quite using cigarettes switch to e-cigarettes to help do so. So, the theory goes, if we hiked the price of e-cigarettes, by raising taxes on them say, we would expect to see demand for cigarettes rise.

In 2013, the state government did just that. It hiked the tax on e-cigarettes from 35% of the wholesale price to 95%. A new paper from economists Henry Saffer, Daniel Dench, Michael Grossman, and Dhaval Dave, titled ‘E-Cigarettes and Adult Smoking: Evidence from Minnesota‘ assesses the consequences. Their findings confirm what theory predicts:

Estimates suggest that the e-cigarette tax increased adult smoking and reduced smoking cessation in Minnesota, relative to the control group…Our results suggest that in the sample period about 32,400 additional adult smokers would have quit smoking in Minnesota in the absence of the tax. If this tax were imposed on a national level about 1.8 million smokers would be deterred from quitting in a ten year period. The taxation of e-cigarettes at the same rate as cigarettes could deter more than 2.75 million smokers nationally from quitting in the same period. 

This study is consistent with prior research which finds that restrictions on youth access to e-cigarettes increases teen smoking rates.

Minnesota’s policymakers encouraged smoking

Minnesota’s policymakers claim to want to reduce smoking. That is one reason they impose the 7th highest cigarette tax rate in the United States. Taxes are disincentives – tax something, and you get less of it.

But if they are serious about reducing the consumption of cigarettes, it makes no sense to increase the price of substitute goods, like e-cigarettes. Indeed, raising the price of a substitute good is, as theory says and evidence bears out, tantamount to increasing the incentive to use cigarettes. Indeed, by hiking taxes on e-cigarettes, Minnesota’s policymakers encouraged people to use cigarettes instead. They may protest that that was no their intention. That is irrelevant. It is the outcome, not their intentions that matter.

Minnesota’s policymakers should cut taxes on e-cigarettes if they want to discourage smoking

If Minnesota’s policymakers are serious about reducing the consumption of cigarettes, theory, and now evidence, is clear about what they should do. They should aim to reduce the price of substitute goods such as e-cigarettes, by cutting taxes on them say.

With substitute goods, like cigarettes and e-cigarettes, where the price of one rises causing demand for the other to rise, it follows that where the price of one (e-cigarettes) falls, this will cause demand for the other (cigarettes) to fall also.

John Phelan is an economist at the Center of the American Experiment.